Decorating

Let fiscal prudence be your guide

Stay within your means when entering home-buying market

Probably the most common problem I see is firsttime home buyers extending themselves too far. Remember, this is your first home and not likely to be your last.

Photograph by: Kurhan
, Fotolia.com

It's been a long time since I bought my first home, but I remember the process being exciting, nervous, stressful and fun all at the same time.

Owning a home is a top priority for many Canadians, for both emotional and financial reasons.

If you're in the market for that first big purchase, consider my tips to avoid financial disaster.

Prioritize

Probably the most common problem I see is firsttime home buyers extending themselves too far. Remember, this is your first home and not likely to be your last. According to Sandra Rinomato from Property Virgins, "The average Canadian moves every three to five years."

Keep this in mind when shopping for a home, and don't worry about having all of your wants covered. Prioritize what's most important and remember that you can eventually move up when financial resources allow.

Stay with in your means

Lenders use two ratios to determine the amount of debt a borrower can manage: Gross Debt Service Ratio (GDSR) and Total Debt Service Ratio (TDSR). Your GDSR - which includes the total cost of housing payments (principal, interest, taxes, and heating) - should not be more than 32 per cent of your gross monthly income. Your TDSR - which is your entire monthly debt load (which includes other debts such as car loans and credit card payments) - should not be more than 40 per cent of your gross monthly income.

Aside from these formulas, it's important to use some common sense. When you go to the bank or a mortgage broker, they will often tell you the biggest mortgage you can qualify for based on your income.

Too many people become house poor because they overextend themselves. Buy a house based on what you can afford, not what you qualify for, and make sure you have a good understanding of your monthly cash flow.

More than a mortgage

On a monthly basis, the cost of owning a home or condo is more than just your mortgage payments. You must also factor in insurance, property taxes, utilities, maintenance or condo fees. You may also want to consider extra lumpsum costs, such as furniture, renovations and landscaping.

Also be aware of closing costs, which can include everything from tax adjustments to home inspection to legal fees. Your real estate lawyer will deal with closing costs and make adjustments for taxes paid, land transfer tax and any outstanding utilities.

Far too often, people determine affordability via the monthly payments. We don't need cash to buy anything these days. When it comes to mortgages, this thinking can be dangerous because we can make things appear more affordable simply by extending the amortization period to lower payments. At one time, the banks wanted to help Canadians make real estate more affordable by offering 40-year mortgages. Extending the amortization to 40 years reduces monthly payments by about 21 per cent, but it almost doubles the total interest paid over the life of the mortgage. This is why the government eliminated 40-year and 35-year mortgages.

We also see people moving toward Home Equity Lines of Credit (HELOC), which can allow for significantly lower monthly payments. But with lower payments, the debt can take a lot longer to disappear. It's smarter to work toward quickly paying off our debts using higher payments.

Use the Home Buyers Plan

The government allows firsttime home buyers to borrow up to $25,000 out of their RRSP toward a house purchase. Although you don't have to pay interest or tax on that money, you do have to pay that back over a 15-year period. If you don't repay 1/15th of the borrowed amount per year, you'll have to add the amount as income. Using this plan can go a long way in reducing the total amount of debt that goes into buying your first home.

Jim Yih (twitter.com/jimyih) is a financial expert who puts financial education programs in the workplace.

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